A spike in German bund yields? Watch for signs of rekindled crisis talk

If you’re worried about ripples from a potential scaling down of central-bank easy money, keep your eyes on Europe.

The U.S. Federal Reserve is set to meet this week, and it may clarify its stance on when it plans to begin winding down its monetary-stimulus program, but a growing clamor of market forecasters are saying the outcome of global central bank monetary policy may have an outsized impact on the euro zone.

Euro-zone bond yields came in dramatically this spring as central-bank monetary policy trumped worries of the sovereign debt crisis and investors searched for yield. But as speculation rises that central banks, particularly the Fed, could slow the pace of stimulus, yields reversed course.

“Bonds of Ireland, Portugal and Greece—the three euro-zone countries under formal bailout programs—have rallied in the past year. Euro-zone tensions have diminished, and the impact of easy monetary policy has prompted investors to scour markets for higher-yielding securities.

“But May and June have seen that rally thrown into reverse. If the liquidity security blanket that investors have wrapped themselves in is being taken away, then fundamentals will play a bigger role.”

But Abigail Doolittle, technical strategist at The Seaport Group, says that technicals suggest bond yields are poised to rise across the euro zone, and that includes the traditionally safer bond markets such as Germany and France. It is unclear when or how a fresh debt crisis would get triggered in the weaker countries, but when it does, signs point to an equally bearish impact on the countries that have served as investor havens, she said.

“Germany is trading in the most bearish set up,” Doolittle said in an interview.

German bonds, or bunds, had been on a multi-year downtrend, but the 10-year bund has leveled off to a side-ways trading range since around mid-2012. That suggests buyers are flirting with a selling mentality. The 10-year bund
/quotes/zigman/15866409BX:TMBMKDE-10Y last traded at 1.474%, according to Tradeweb. But if the yield climbs above 1.71%, its high point in 2012 and 2013, technical analysis suggests it would be a fairly swift climb up to the 2011 high of 3.48%, and after that a 2008 high of 4.62%, Doolittle postulates. A “black swan” scenario could push the German yield to its 1990 level of 9% in the medium- to long-term, she said.

The Seaport Group/ Bloomberg

Doolittle writes in a recent report:

“The importance of this potential weakness in German and French government debt is significant and should not be overlooked considering it may signal that investors are likely to classify these securities as something other than safe haven assets and a reevaluation that could be matched by downgrades from the credit ratings agencies.”

The French 10-year bond yield, currently at 2.08%, according to Tradeweb, could rise to 4.84% in the near to medium term. The Italian 10-year bond yield, currently at 4.27%, could rise to 7.25% in three to 18 months. The Spanish 10-year yield, trading at 4.58% Monday, could rise to 7.50%.

Doolittle is not the only one preparing for a spike in yields. If central-bank monetary policies become less of a factor underpinning bond yields, economic fundamentals would become a more prominent determinant of yields. The Journal reports on the weaker euro-zone countries:

“But economic pressures, especially gross domestic product that has fallen faster than expected, have heightened concerns about the countries’ debt burdens. Debt that grows too fast, relative to the economy, is the principal risk for most of Europe’s weaker states—and for their bond investors.”

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